There's More to Wealth Than Your Portfolio

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. Investors often focus on age and risk tolerance when making asset-allocation decisions. But other factors should be in the mix, too. Joining me to discuss that topic is David Blanchett. He is head of retirement research for Morningstar.

David, thank you so much for being here.

David Blanchett: Thanks for having me.

Benz: You worked on a paper where you looked at what you call total wealth allocation. The basic suggestion is that people should look at their total wealth in aggregate, thinking about their human capital, homes they own, the whole gamut of ownership. Let's talk about what you see are the key other factors apart from just the financial assets that investors should have in mind when thinking about their asset allocation?

Blanchett: Sure. I guess the overarching theme is that no portfolio is an island. A portfolio is your financial assets. It's one part of someone's total economic worth. And things like your real estate--your house--your pension all should come into play when thinking about how do I build the right portfolio for me?

Benz: Let's take these one by one. The key things that you think investors should be thinking about when they are looking at asset allocation. One is the industry in which they work--so not just their human capital and how long they will be working, but also where they are working. How should that influence the decision-making, say, if someone works in the financial sector?

Blanchett: Human capital is that ability for us to go out and earn a wage. Everyone's human capital is different. To your point, someone who works for a bank--banks are usually more like large-value-type stocks--and so if you work for a bank you should probably hold, for example, less large value in your portfolio.

Another example is if you are a real estate agent, you should probably hold fewer REITs in your portfolio. If you work for an energy company in Texas, you should probably hold fewer commodity stocks, for example, because each of those is kind of correlated to your portfolio so you want to diversify away from that if you can in your financial assets.

Benz: Your economic fortunes tied to your job are going to fluctuate in a certain way, and the idea is that you don't want your portfolio necessarily fluctuating in that same way, as well?

Blanchett: Correct. I think a great example is former Enron employees who had all of their 401(k) assets invested in Enron stock and their personal portfolios, as well. So at the same time they had a bad shock: They lost their jobs and they lost their portfolios. So the goal is to smooth those changes in wealth over time.

Benz: Another piece of this is pension assets, Social Security assets, how they should be counted and how they should influence asset allocation. I know this is a topic of great interest for our Morningstar.com users. How should they be thinking about that question? If they have a pension that's going to supply most of their living expenses in retirement--that's a shrinking share of the population, but say they are in that position--how should that influence your asset allocation?

Blanchett: For most retirees, their largest asset is actually Social Security. If you look at the net present value of their benefits, that's their largest single holding. And so the perspective on this piece is that Social Security or a pension is a government bond. It is effectively a guaranteed stream of income. The more you have in pensions and Social Security, the more aggressive you can actually be in your portfolio because it's a smaller piece of your overall wealth.

Benz: And housing wealth is another component that's obviously, for a lot of people, a very big share of their net worth, too. How should you think about that? It maybe stands to reason that you wouldn't want to own a bunch of real estate securities in the portfolio. Anything else?

Blanchett: I think that housing is unique because it's the one asset that a lot of us own that is leveraged. If you buy a home and you put 20% down, you have 5 times the leverage in the home. If you bought a new house in Phoenix five years ago, you could have lost your entire down payment. There is some unique risk with housing. But to your point, asset classes like REITs can make a lot of sense for some investors. But if you are an individual who owns a relatively expensive home, you probably don't need to own REITs and have this large real estate holding as part of your portfolio.

Benz: But if you have rental properties? Is that same thing?

Blanchett: It's the same thing. Obviously, real estate prices differ across where you are, where the property is. But obviously, rental real estate is going to be correlated to probably your house and REITs in general. So, I would say that be careful in kind of having too much in REITs in your portfolio and too much in real estate assets as part of your other economic work.

Benz: David, your overall message is don't just look at your financial assets in a vacuum. Really pick your head up and think about your total wealth allocation and think about all the risk factors that you might have going on.

Blanchett: It is. And I think that this kind of applies to things like 401(k) plans, for example, because you have a lot of investors who have the same risk characteristics. For each individual, it's kind of hard to pin this down. But obviously, you don't want to have all your eggs in one basket. Seek to minimize those risks as best as you can as part of your financial assets because that's your diversifier. It's really hard to sell your human capital, to sell your pension, to sell your home. It's easier to say, "Hey, let's look at my other assets, my other risks and build my portfolio accordingly."

Benz: David, thank you so much for being here to share these insights.

In this special presentation, get the answers to key questions about the quality of your plan, whether your savings are on track with your goals, how to allocate assets, and what to do with assets when you leave your job.

Roundtable Report: ChristineBenz , John Rekenthaler, and David Blanchett weigh in on how this savings vehicle can be made better and used better by the increasing number of Americans who will depend on it.